Price Controls
Policy Levers: Price Controls
Overview
Definition: Price controls are governmental policies that impose legal limits on the market prices of specific goods or services.
Reasons for Imposition
Help disadvantaged groups: Governments may impose prices to protect vulnerable consumers.
Manage affordability: Ensures that essential goods remain accessible.
Seeks favor of interest groups: Aligns with the desires of specific political lobbying groups.
Types of Price Controls
Price Floors
Definition: A price floor sets a legal minimum price for a good or service, prohibiting prices below this level.
Examples:
Agricultural price supports.
Minimum wage laws.
Binding Price Floor
Definition: A binding price floor is set above the equilibrium price.
Impact on Market:
Example representation:
Market Price (P_Market): $5.50
Price Floor: $7.00
Quantity Demanded (Q_D): 4.5
Quantity Supplied (Q_S): 6
Figure: Binding price floor results in reduced quantity demanded.
Total Surplus with Binding Price Floor
Consumer Surplus (CS): $10.125
Producer Surplus (PS): $10.125
Total Surplus (TS): $20.25
Deadweight Loss (DWL): $0.00 when binding.
Non-Binding Price Floor
Definition: A non-binding price floor is set below the equilibrium price.
Impact on Market:
Example representation:
Market Price: $5.50
Price Floor: $3.00
Quantity Demanded: 4.5
Quantity Supplied: 4.5
Total Surplus with Non-Binding Price Floor is unchanged.
Addressing Surplus of Goods
Method: Surplus goods can be sold on the black market; for example, at $4 per unit.
Historical Example of Price Floors
Context: The US government historically established binding price floors on milk, resulting in the government buying surplus milk, leading to deadweight loss (often referred to as government cheese).
Price Ceilings
Definition: A price ceiling sets a legal maximum price for a good, preventing prices from exceeding this limit.
Examples of Price Ceilings:
Price-gouging laws.
Rent control measures.
Binding Price Ceiling
Definition: A binding price ceiling is set below the equilibrium price.
Impact on Market:
Example representation:
Market Price (P_Market): $5.50
Price Ceiling: $3.00
Quantity Demanded (Q_D): 7
Quantity Supplied (Q_S): 4.5
Consequences: Leads to shortages in the market.
Total Surplus with Binding Price Ceiling
Consumer Surplus (CS): $10.125
Producer Surplus (PS): $2.00
Total Surplus (TS): $14.00
Deadweight Loss (DWL): $6.25.
Non-Binding Price Ceiling
Definition: A non-binding price ceiling is above the equilibrium price.
Impact:
Market operates normally without changes in price ceilings.
Coping Mechanisms for Buyers in Shortage
Wait for availability.
Buy on black market: Limited to those with higher willingness to pay; for example, at $8 per unit.
Price-Gouging Laws
Objective: Maintain accessibility to necessities during crises.
Impacts: Can create a shortage during disasters; over 35 states have these laws.
Zoning
Definition: Zoning policies determine land use and development intensity in specific geographic areas.
Examples:
Minimum and maximum lot sizes.
Height restrictions on buildings.
Historical preservation laws.
Urban growth boundaries.
Separation of industrial zones from residential areas.
Floor-Area Ratio Limits (FAR)
Example Limits:
FAR of no greater than 0.5: one-story structure can cover a maximum of 50% of the lot; a two-story structure can cover a maximum of 25%.
Reasons Cities Adopt Zoning Policies
Prevent disamenities: Limit negative externalities from certain developments.
Example: Suburban sprawl can worsen air quality and increase costs for public services.
Appease neighborhood activists: Homeowners want their property values preserved, thus leading to restrictions benefiting them at the expense of others.
Consequences of Zoning Policies
Higher Prices and Less Housing: Increased scarcity of affordable housing due to limits on development.
Deadweight Loss: In the absence of externalities, market inefficiencies can arise.
Rent Control
Objective: Make residential rent affordable.
Policy Mechanism: Establishes a price ceiling for rental units.
Consequences:
Rental shortages due to limited supply.
Deadweight loss arises from inefficiencies in the housing market.
Historical Example of Rent Control
Example: Median rent prices in San Francisco ($3,450) compared to Houston ($1,900) demonstrate the impacts of rent control and zoning differences.
Conclusions on Rent Control
Rent Control Impact:
Fewer available rental units due to conversion to condos, lower construction rates, and reluctance from current tenants to move out.
Black market prices surpass regulated and market prices due to rationing based on willingness to pay.
Reduced quality of housing units.
Assar Lindbeck's Consensus on Rent Control
Noted as an inefficient approach to urban housing policy; indicates that it leads to destruction of city environments and poorly targeted protections for tenants.
Minimum Wage
History: Minimum wage was established in 1938 at $0.25 per hour, adjusted for inflation to about $4.81 in 2021.
Current Federal Minimum Wage: $7.25 per hour with expanded coverage.
Examples of local minimums include D.C. at $17 per hour and Oregon with tiered rates.
Predictions Related to Minimum Wage Implementation
Unemployment may increase.
Existing workers retain higher earnings but new job seekers struggle.
Evidence on Minimum Wage Effects
Job Losses: No consensus on job loss due to binding minimum wage; evidence shows largely stable employment.
Business Responses: Common responses include raising prices to cover increased labor costs.
Seattle case study indicates price increases in services related to the minimum wage.
Impact on Low-Skilled Workers
Research indicates no clear consensus, but some evidence suggests that minimum wage increases can maintain or improve earnings despite slight reductions in hours worked.